Google reached $1 billion in revenue within five years of
incorporation, and now has a market capitalization of over $400
billion. Twitter showed no focus on revenue in the first
five years, but was able to parlay 500 million users into a
$22 billion public company, now growing revenue.

Every startup dreams of achieving that milestone, when they can
focus more on scaling the business and enjoying their
earnings rather than fighting for another investment
infusion. Most are still confused about the right
priority. Should they focus on increasing revenues and
profitability, or entice more and more users with “free”
services to increase their valuation.

Traditionally, it was simple. A business only achieved
critical mass by becoming cash-flow positive. Revenue growth
(top line) then had to be converted into profit growth (bottom
line), before a business was deemed to be self-sustaining and
worthy of public investment.

It’s only been in the last 10 years that social-media companies,
such as Facebook and Twitter, have achieved market
valuations in billions of dollars, while clearly sacrificing
revenue to gain users. In my view, the pendulum is swinging
back, with investors looking more for the traditional indications
of business integrity, stability and growth. Here are
factors to consider:

1. Some element of organic growth is a good
thing. The purest form of capitalism has always
meant charging a fair price and making a fair profit.
Re-investing profits to grow the business is organic
growth. The concept of free goods and services to get you
hooked, financed by deep pockets or advertising, seems
marginally ethical to many.

2. Long-term stability requires revenue growth and
profit. Most modern investors still look for a
business model that embodies a gross margin over 50
percent and a net margin in the 20
percent range. A healthy business, ready to scale, has
been doing this for a year or more, with an existing customer set
generating a non-trivial and growing revenue stream.

3. High customer loyalty and high team
passion. Startup productivity is embodied in key
ratios, including low cost of customer acquisition, high
retention and high revenue per employee. High customer
churn and lackluster team members are still indicators of a
high-risk investment opportunity to be avoided by both
public and private investors.

4. Growing appreciation for the value of the solution
provided. These days, you need customer evangelists who
see the value and will pull in their friends through viral
actions to keep the business growing. Too many of the high
user-growth startups have been fads, and numbers can go down as
fast as they go up, as per Friendster and MySpace.

5. Understanding competitive early-mover
requirements. First movers in a new space need
users more than revenue to maintain market share, so investment
pitches need to highlight this priority in requests for funding
resources. More complex and defensible businesses should
highlight their organic drive to profitability and brand
leadership.

Unfortunately, the Internet and heavily-funded startups have
nurtured a customer expectation of free web services and
smartphone apps. In these domains, it is now difficult to
monetize at all until you have a large critical mass of
users. Growth scaling is important in these cases, both
before and after revenue flow begins. The business plan must
reflect both growth phases.

Even after a startup has achieved a critical mass of users, the
expectation of long-term revenue growth and profitability does
not go away. Twitter is facing this challenge right now, as
the large majority of public investors expect a near-term
financial return on their investment, every quarter of every
year.

A higher focus on user growth may be necessary early, but is
never sufficient. If you are in it for the long run, don’t
forget the basic business principle that if you lose money on
every customer, you can’t make it up in volume.